Tax-Free REIT Spinoffs Are Curtailed

The IRS issued temporary and proposed regulations on Tuesday to implement the amendments to the real estate investment trust (REIT) spinoff rules enacted in the Protecting Americans From Tax Hikes (PATH) Act of 2015 (enacted as part of the Consolidated Appropriations Act, 2016, P.L. 114-113) and to prevent taxpayers from avoiding the effects of the REIT spinoff changes by requiring corporations that move assets to a REIT within 10 years of the spinoff to recognize gain as if the property had been sold at its fair market value (FMV) on the deemed sale date (T.D. 9770).

Editor’s note: These proposed regulations were identified as burdensome by the Treasury Department in July 2017 and are being reviewed for possible modification or withdrawal. See “Treasury Identifies 8 Regulations as Burdensome.”

Before the PATH Act, the IRS was aware of transactions in which a C corporation that does not qualify as a REIT distributes the stock of a controlled corporation in a Sec. 355 transaction so that either the distributing corporation or the controlled corporation can qualify as a REIT. In many cases, a C corporation that owns both assets qualifying as REIT assets and nonqualifying assets transfers either the REIT assets or the nonqualifying assets to a controlled corporation in exchange for its stock and then distributes the stock to its shareholders. Then, the corporation holding the REIT assets elects to be a REIT. If the transaction satisfies the reorganization requirements of Secs. 368(a)(1)(D), 355, and 361, no gain is recognized on either the transfer of assets by the distributing corporation to the controlled corporation or the distribution of the controlled corporation stock to the shareholders of the distributing corporation.

Although the PATH Act amendments curtailed some of these transactions, the IRS is still concerned that taxpayers will use variations of the transactions previously described to circumvent those PATH Act changes. In particular, there is concern that corporations affiliated with the distributing corporation or the controlled corporation could be used to circumvent the congressional amendments.

The regulations therefore require a C corporation engaging in a conversion transaction involving a REIT within the 10-year period following a related Sec. 355 distribution be treated as making an election to recognize gain and loss as if it had sold all of the converted property to an unrelated party at FMV on the deemed sale date. Under the prior regulations, taxpayers could elect to use the Sec. 1374 built-in gain period to recognize any gain, but these regulations eliminate that option.

Proposed regulations issued at the same time and that include the text of the temporary regulations also include a change in the definition of converted property to “any property the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis of property owned by a C corporation that becomes the property of a RIC [regulated investment company] or a REIT” (REG-126452-15).

Consistent with the PATH amendments, the temporary regulations will not apply if both the distributing corporation and the controlled corporation are REITs immediately after the Sec. 355 distribution date and at all times for two years after. Second, the rules do not apply to certain Sec. 355 distributions in which the distributing corporation is a REIT and the controlled corporation is a taxable REIT subsidiary.

Consistent with the effective date of the PATH Act amendments, these regulations do not apply to distributions undertaken in a transaction described in a ruling request initially submitted to the IRS on or before Dec. 7, 2015, which has not been withdrawn or ruled upon on that date.

These temporary regulations apply to predecessors and successors of the distributing corporation or the controlled corporation and to all members of the separate affiliated group, as defined in Sec. 355(b)(3)(B), of which the distributing corporation or the controlled corporation are members.

—Sally P. Schreiber (sschreiber@aicpa.org) is a Tax Adviser senior editor.